"The Act prescribes a shared scheme of regulation," William J. Sweet, Jr., Michael D. Dorum, and Joshua B. Warren write in "The Dodd-Frank Act: Commentary and Insights," published by Skadden, Arps, Slate, Meagher & Flom. "The CFTC and the SEC share the power to regulate derivatives clearing organizations, designated contract markets, and swap execution facilities based on the type of swap at issue." While the two must coordinate their activities, they also will have autonomy within their areas of jurisdiction. "Although the CFTC and SEC must treat functionally or economically similar products and entities in a similar manner, they need not treat them in an identical manner," the three attorneys write.
All of these new tasks have some asking if the agencies might become overburdened. "The question is, ‘Do the CFTC and SEC have the staff to write those rules and in what order are they going to be written and do they have the resources to actually implement them given the significant number of comments they’re going to get?’" John Fay, head of the Americas region for Newedge, says. CFTC Chairman Gary Gensler says he has the staff to write the rules but will need another 400 people to implement them a year down the road.
Japan’s "comprehensive exchange"
Not to be outdone, Japan has embedded OTC clearing in its long-stalled reform process. In May, Parliament passed a bill mandating the use of central counterparties (CCPs) for large-scale OTC derivatives transactions by November 2012, and even before that, the Tokyo Stock Exchange and the Tokyo Futures Exchange had begun building OTC platforms. The Tokyo Commodity Exchange (TOCOM), meanwhile, is researching a way to clear OTC commodity products such as metals and energy.
Neither is yet complete, however, and FIA Japan boss Mitch Fulscher says the door also is open to non-Japanese clearinghouses. "There has also been interest expressed by overseas clearing organizations to offer clearing of Japanese products," he says. "The question is whether this can be a profitable business. Although there is a volume of business in Japan in these products, it does not seem to me to be adequate to have more than one clearinghouse involved in clearing these products."
He points out that the move to clear OTC is part of a larger regulatory process that has been progressing slowly and haltingly for years, and believes the advent of OTC clearing could overcome inertia in that endeavor as well.
"This situation of having multiple exchanges and multiple clearinghouses is a result of the regulatory ‘silos’ that separate markets by product," he says. "However, the laws...now permit cross-over [which] should help to break down these silos and permit the exchanges and their clearinghouses to come together in a rational way to fully serve customers. This urgently needs to take place. The development of OTC clearing could be the opportunity for exchanges to meet together and begin the process of forming an integrated market."
The European process
Within Europe, reforms are progressing on several levels: within EU countries (see "The end of the FSA," below), among EU countries and at the commission level. On the OTC derivatives front, the European Commission received nearly 200 official comment letters by the time it had closed its "Public Consultation on Derivatives and Market Infrastructure" in July. Because the proposal won’t be ready until September, it’s not clear what form the Commission’s new derivatives directive will take.
On a broader level, the European Securities Markets Authority (ESMA, formerly the Committee of European Securities Regulators) has been granted new pan-European powers as of next year, and is now advising the European Commission on its proposed overhaul of the already-sweeping Markets in Financial Instruments Directive — a massive endeavor in its own right that came into effect in 2007 and was designed to forge a more unified capital market. Under proposals released in late July, ESMA wants EU member states to agree on a mandatory two-year deadline for making the continent’s fragmented markets work as one by mandating coordinated pricing of securities. If the states can’t coordinate their practices within that period of time, ESMA will look to do it for them.
ESMA is one of three committees that advise the European Commission on regulatory matters (the others are the Committee of European Banking Supervisors and the Committee of European Insurance and Occupational Pensions Committee) and the commission has proposed replacing all of them with something tentatively called the European System of Financial Supervisors, which Belchambers characterizes as "a central regulator of regulators."
"They will coordinate regulatory approaches across the member states, and they will have a number of roles in developing common standards of implementation enforcement and so forth, but direct supervision is likely to be limited to credit rating agencies and less likely clearing CCPs," Belchambers says. "The guts of supervision of the main markets and the main financial service providers will remain with the supervisory member state supervisor authority."
Many EU initiatives, such as the Alternative Investment Funds Directive (AIFD), have floundered in the wake of unresolved differences. The AIFD was designed to regulate hedge funds and private equity, but has stalled over the same turf wars that have hampered the EU since its inception: should fund managers be treated as members of a single market, or should they be subject to the regulations of the member state within which they reside?
"Some key players will take new prominence in the new world," DeWaal says. "The first player will be the professional trading groups, because they will take the role that currently is monopolized by the dealers and they will help to diversify liquidity sources." The second group, he says, is swap execution facilities, which are execution platforms for OTC derivatives. All of these changes will need to be somewhat normalized across the Atlantic to avoid jurisdictional shopping for regulatory weak spots once credit markets loosen up. Gensler (see "Gensler: Correcting the record on OTC regulation") was optimistic on this, saying, "Capital at risk knows no geographical boundary so it is very important to work with our international counterparts to get as consistent as possible."
The end of the FSA
No regulator has gone from hero to zero faster than the UK’s Financial Services Authority (FSA), which was cobbled together from several entities over the past quarter century and became the agency that most other European regulators — especially those of new member states — and a number of international authorities emulated when trying to walk the fine line between over-regulation and excessive lenience.
As a single regulator for banks, insurance, and financial services, the FSA was responsible for systemic risk, consumer protection, and law enforcement; and it oversaw a period of tremendous growth. It also advocated a "light touch" regulatory approach — one that came under fire as the market for credit-default swaps imploded two years ago. Indeed, as the crisis grew, the FSA reversed its previous strategy and became increasingly aggressive in pursuing sluggish bankers.
Pending approval by Parliament, its prudential regulatory structures and the oversight of systemically important institutions will be absorbed into a new Bank of England (BoE) subsidiary called the Prudential Regulatory Authority by the end of 2012. Its consumer protection, markets and remaining divisions will be folded into a new entity called the Consumer Protection and Markets Authority (CPMA), and its law enforcement structures will be folded into a new agency focused on white-collar crime.
"In general terms, I think we know where we are going, but the specifics of it haven’t really been addressed," says Futures and Options Association CEO Anthony Belchambers. "There are questions about scope between the Prudential Regulatory Authority and the CPMA. For example, it’s not clear what happens to the prudential regulation of non-systemically important, smaller, broker-dealers. Splitting out the regulation of CCPs will be a headache for those that are vertically integrated with exchanges." In late July, the UK Treasury published a consultation paper called "A New Approach to Financial Regulation: Judgment, Focus and Stability," which is available at www.bankofengland.co.uk and says the CPMA will essentially continue to follow FSA principles, but in two separate tracts.